Have IFRS Affected Earnings Management in The European Union?

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Have IFRS Affected Earnings

Management in the European
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a
Susana Callao & Jos Ignacio Jarne
Department of Accounting and Finance, University of

Zaragoza, Zaragoza, Spain
Published online: 24 Nov 2010.
To cite this article: Susana Callao & Jos Ignacio Jarne (2010): Have IFRS Affected
Earnings Management in the European Union?, Accounting in Europe, 7:2, 159-189
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Accounting in Europe
Vol. 7, No. 2, 159 189, December 2010
Have IFRS Affected Earnings

Management in the European
Union?
Downloaded by [41.249.196.166] at 17:50 06 May 2013
SUSANA CALLAO and JOSE IGNACIO JARNE

Department of Accounting and Finance, University of Zaragoza, Zaragoza, Spain
ABSTRACT There has recently been considerable discussion of those features of IFRS
that are likely to help improve financial reporting in the European Union. However,
certain issues may also have a negative impact on the quality of information. This paper
focuses on the effect of IFRS on earnings management. Its main purpose is to examine
whether the adoption of IFRS in the European Union has increased or decreased the
scope for discretionary accounting practices by comparing discretionary accruals in the
periods preceding and immediately after the regulatory change. Another objective is to
determine which firms features and country factors may explain the accounting
discretion observed before and after IFRS. We consider a sample of non-financial firms
listed on 11 EU stock markets. The results obtained show that earnings management
has intensified since the adoption of IFRS in Europe, as discretionary accruals have
increased in the period following implementation. The variables explaining accounting
discretion are the same before and after IFRS (business size, leverage, investor
protection and legal enforcement). These results suggest that variations in earnings
management might be due to some room for manipulation under international standards
when compared with local standards.
1. Introduction
Opportunistic behaviour by managers in the area of financial reporting has been a
concern for many years. Where ownership and management are separated, the
accounting function is affected by the agency problem (Jensen and Meckling,
1976). This concerns the difficulties that arise under conditions of incomplete
Correspondence Address: Susana Callao, Department of Accounting and Finance, Faculty of Economics and Business, University of Zaragoza, Gran Va, 2, 50005 Zaragoza, Spain. Fax: +34976
761769; Tel.: +34976 761791; Email: scallao@unizar.es
1744-9480 Print/1744-9499 Online/10/02015931 # 2010 European Accounting Association
DOI: 10.1080/17449480.2010.511896
Published by Routledge Journals, Taylor & Francis Ltd on behalf of the EAA.
160
S. Callao and J. I. Jarne
and asymmetric information when a principal hires an agent, such as the problem
that the two may not have the same interests. In this context, managers may have
an incentive to make decisions in their own interest when preparing financial
information, to the detriment of the firms owners (Fama, 1980; Fama and
Jensen, 1983).
Accounting standards may have an impact on the possibility of opportunistic
behaviour. Rigid rules providing limited accounting options and restricting the
scope for subjective judgments constrain the ability of managers to behave opportunistically. However, more flexible rules providing greater scope for choice and
involving a higher degree of implicit subjectivity in the application of criteria
allow managers a wide field to exercise their discretion (Jeanjean and Stolowy,
2008), which they may do in their own interest in the absence of effective
control mechanisms. So, the more flexible are the rules, the higher is the possibility of earnings management practices (defined as those accounting practices
carried out by management with the intent of manipulating the resulting
figures to their advantage).
However, the notion of earnings management includes not only accounting
policies but also the manipulation of real transactions. Rigid accounting policies
can lead to an increase in the manipulation of real-life transactions in order to
obtain the wanted profit (Nelson, 2003; Ewert and Wagenhofer, 2005).
The introduction in 2005 of IFRS for groups listed on official stock markets in
the EU created a new scenario for management in the field of financial reporting
in the member states. The present study seeks to throw light on the effects of
IFRS on earnings management.
The IASB framework identifies representational faithfulness as one of the
prime qualitative characteristics that make the information useful to users
(high quality information). This study focuses on earnings management as an
obstacle to representational faithfulness.
We define earnings management as the use of accounting practices within the
limits available within a comprehensive basis of accounting by management in
order to achieve a desired result. Other definitions of earnings management can
be found in Schipper (1989), Apellaniz and Labrador (1995) and Healy and
Wahlen (1999). We measure earnings management in terms of discretionary
accruals; as an alternative measure we analyse the discontinuity in zero of
return on assets.
Some arguments supporting the contribution of IFRS to improvements in
financial reporting are based on the fact that the new standards plug gaps in
local accounting regulations, by providing recognition and measurement rules
for certain issues that had not been addressed in some countries (see, inter
alia, Garca-Ayuso and Monterrey, 2006). IFRS are also considered to require
disclosure of more information than previously, which could be expected to
reduce information asymmetry between insiders and outsiders.
However, various aspects of IFRS that may have negative impacts on the
quality of financial reporting have been highlighted in the literature in recent
Have IFRS Affected Earnings Management in the European Union?
161
years (e.g. Ormrod and Taylor, 2004). These include the greater flexibility
offered by IFRS in comparison to the local standards of many EU countries,1
the subjectivity implicit in the application of certain criteria, including fair
value, and the relaxation of requirements concerning the presentation of financial
statements. Such matters may provide openings for discretionary accounting and
opportunistic behaviour, although the way firms use this discretion is likely to
depend on their reporting incentives. It is also quite possible that levels of discretionary accounting would be expected to increase in the early years after the regulatory change in comparison to the situation under local standards, given the
novelty of the new rules and potential difficulties with interpretation.
Other important features of the financial reporting system, such as the enforcement mechanisms, may influence the expected quality of financial reporting
under IFRS (Ball et al., 2003; Dao, 2005; Ball, 2006; Daske et al., 2008). The
accounting practices adopted by firms also depend on other country factors,
such as investor protection (Leuz et al., 2003), and some firm features, such as
size (Watts and Zimmerman, 1990; Scott, 1991), growth (Skinner and Sloan,
2002) or leverage (DeFond and Jiambalvo, 1994; Sweeny, 1994; Bikky and
Picheng, 2002; Jelinek, 2007).
In this context, the objective of this paper is to examine whether the adoption
of IFRS in the European Union has increased or decreased the scope for discretionary accounting practices by comparing discretionary accruals in the periods
preceding (pre-IFRS) and immediately after, the regulatory change (postIFRS). We also try to determine which firm features and country factors may
explain the accounting discretion observed before and after IFRS. On the one
hand, we focus on the size, growth and leverage of the companies, and on the
other hand, on the investor protection and legal enforcement in each country.
To this end, we consider a sample of non-financial firms listed on 11 EU stock
markets. Local standards prevailing in the EU before the adoption of IFRS differed considerably, despite being based on the same EU Directives. This
means the effects of IFRS on discretionary accounting may vary from country
to country.
If the study finds IFRS have reduced discretionary accruals, this would imply
that the use of IFRS had resulted in better accounting information. If, however,
the conclusion is that IFRS have caused an increase in discretionary accruals,
then the basis of accounting may have helped improve financial reporting
through provision of additional information but allows greater manipulation.
Should accounting discretion be explained by firm features and/or country
factors, it would mean that convergence is not sufficient to reduce earnings management and may require strong regulatory frameworks, including enforcement
mechanisms.
The rest of this paper is structured as follows. We continue with a review of the
existing literature, and then we go on to describe the sample and the methodology
employed in the third section. The fourth section presents the results obtained
which are discussed in the fifth one. The paper ends with our main conclusions.
162
2.

Literature Review
The mandatory adoption of IFRS for listed companies in the European Union is
an important regulatory change in accounting history. This regulatory change
raises new expectations for the agents concerned with the preparation and analysis of financial information and is expected to enhance the comparability of financial reporting, to improve corporate transparency and to increase the quality of
the financial reporting (see EC Regulation No. 1606/2002).
Nevertheless, the implementation of IFRS in many European countries, in particular in those traditionally falling under the European Continental model (e.g.
France, Germany, Portugal or Spain), has entailed a considerable change in the
philosophy of accounting. There has been a shift from a rules-based system to
a principles-based system. This implies a need for both managers and auditors
to make frequent use of their professional judgment in order to ensure that the
financial statements reflect the economic substance of transactions (Wustemann
and Kierzek, 2005). As Carmona and Trombetta (2008) argue, it involves major
changes in the expertise needed by accountants and, hence, in their educational
background, training programmes and in the organisational and business
models of accounting firms.
It might be thought that the use of a principles-based model could provide more
flexibility in interpretation and therefore, a higher degree of manipulation. As
Jeanjean and Stolowy (2008) point out, the application of accounting standards
such as IFRS involves considerable judgement and the use of private information,
and provides managers with substantial discretion. Iatridis and Joseph (2005) also
observe that flexibility in financial reporting may enhance the scope for income
smoothing. However, they suggest that it can be mitigated by an appropriate
choice of accounting policies by companies. The question, then, is whether the
application of IFRS and the consequent increase in the use of professional judgment have led to an improvement in financial reporting.
Recent studies have suggested that the success of IFRS in improving financial
information is affected by factors such as national culture, the legal and institutional framework, rule enforcement, reporting incentives of firms, the nature
of rules, etc.
Zeff (2007) affirms that cultural differences (business and financial culture,
accounting culture, auditing culture and regulatory culture) between countries
are factors that could impede or interfere with promoting worldwide comparability. Furthermore, problems of interpretation, language, terminology, etc. obstruct
convergence.
Ding et al. (2007), using a sample of 30 countries, conclude that simply adopting IFRS may not necessarily improve national accounting systems unless
countries also implement profound changes in economic development policy,
corporate governance mechanisms and financial market functioning in general.
Other studies have pointed out the importance of enforcement mechanisms.
Thus, Dao (2005) argues that improving the quality of financial information is
163
not simply a matter of switching to IFRS. Rather, the change must be

accompanied by mechanisms to oversee the appropriate application of the new
standards. The research describes the method used by the French stock exchange
regulator for monitoring compliance with reporting rules.
Ball et al. (2003), Ball (2006), Barth et al. (2008) and Daske et al. (2008) have
also linked the success of IFRS to enforcement mechanisms. They conclude that
such success is difficult to attain without the existence of effective enforcement
mechanisms. Furthermore, these and studies such as Jeanjean and Stolowy (2008)
highlight the importance of reporting incentives of firms, which are shaped by
many factors, including countries legal institutions, various market forces and
firms operating characteristics.
Some authors have analysed the characteristics of IFRS, some of which may
have affected the financial information prepared under such standards. Ball
(2006) analyses the advantages and drawbacks of IFRS for investors. One of
the aspects under study is fair value accounting, where the author finds an
increased opportunity for manipulation. Nobes (2006) identifies some IFRS
characteristics which might allow the possibility that accounting differences
exist at an international level, showing 18 overt options and 21 covert options
or vague criteria. In our opinion, they also provide an opportunity for manipulation within the limits of the accounting rules. It is very difficult to prove that
management chose an inappropriate accounting treatment.
However, recent research related to different countries around the world, using
different measures of properties of earnings, such us timelines, conservatism,
value relevance, earnings volatility or earnings management, has analysed the
impact of IFRS on the quality of financial reporting with divergent results.
Daske and Gebhardt (2006) focus on firms in three European countries
(Austria, Germany and Switzerland) which had voluntarily adopted IFRS or
US GAAP and firms which mandatorily adopted such standards. Using disclosure
quality scores they show that the quality of financial reporting has increased
considerably since the adoption of international standards.
Meanwhile, Eccher and Healy (2003) analyse the relevance of information
based on Chinese and international principles for valuation purposes. In
general, their results do not support any gains in the relevance of IFRS-based
information, although some improvement was found in firms owned by local
investors.
Ormrod and Taylor (2004) assess the impact of IFRS on loan agreements in the
UK. These authors are convinced that the change to international standards would
cause greater earnings volatility and that it facilitates income smoothing for a
variety of reasons, including the application of fair value measurement, the existence of certain flexibility in some areas and the lack of adequate enforcement
mechanisms to guarantee IFRS compliance.
The value relevance of financial reporting under US GAAP, IFRS and German
accounting standards is examined by Bartov et al. (2005) by using earnings as the
independent variable. Their results show that information prepared by profitable
164
firms under international standards is more relevant than under German accounting principles, but it is less relevant than information reported under US GAAP.
Hung and Subramanyam (2007), also for the case of Germany, find no evidence
for increased value relevance following the application of IFRS.
Based on earnings management as measure of quality, Van Tendeloo and Vanstraelen (2005) observe no differences in earnings management between firms
preparing their financial statements under German accounting principles and
those voluntarily adopting international standards.
Barth et al. (2008) determine the quality of reported profits by reference to
properties such as value relevance, appropriateness and earnings management.
In an analysis of 21 countries, they find that the figures reported by firms applying
IFRS are more relevant for valuation purposes, recognise losses on a more appropriate basis and are less affected by earnings management than the information
disclosed by companies preparing their financial statements on the basis of
local standards. They also observe an improvement in the quality of financial
reporting since the application of IFRS. As this improvement might be related
to changes in firms incentives and the economic environment, they include
research design features to mitigate the effects of both.
There are numerous reasons for these divergent results, four of which are
picked out as crucial by Barth et al. (2008). Firstly, firms preparing to adopt
IFRS are likely to make the transition gradually, by changing policies based on
national standards to bring them more closely into line with IFRS. Secondly,
developing economies lack the infrastructure to enforce the application of
IFRS. Thirdly, the studies differ in the effectiveness of controls for incentives
associated with a firms use of a particular set of accounting standards and the
effects of the economic environment. Fourthly, the studies use different
metrics, draw data from somewhat different time periods and use different
control variables.
Of all variables used to analyse the impact of IFRS on financial reporting,
including quality indices, value relevance, earnings volatility, appropriateness
and earnings management, among others, we focus on earnings management,
which we measure in terms of discretionary accruals, the most widely used
tool to detect possible manipulation of a firms financial statements.
To evaluate the impact of IFRS on the discretionary accounting practices in the
EU, we formulate the following hypothesis:
Hypothesis 1: The adoption of IFRS in Europe negatively impacts reporting quality because it increases the scope for earnings management.
Although accounting standards play an important role in the accounting practices, we should not forget the importance of other factors related to the firm and
country.
Prior research finds that accounting choices are associated with several firm
variables, as size, leverage, bonus plans, international trade or industry (Watts
165
and Zimmerman, 1978, 1990; Hagerman and Zmijewski, 1979; Zmijewski and
Hagerman, 1981; Dhaliwal et al., 1982, 1999; Skinner, 1993; Christie and Zimmerman, 1994; Bowen et al., 1995; Cullinan, 1999; Astami and Tower, 2006).
Some studies find relationships between different country factors and accounting practices chosen by firms. Some of these factors are the ownership structures,
the investment opportunity set, the importance of the stock market, the degree of
investor protection, legal enforcement, book tax alignment or the legal system
(Dhaliwal et al., 1982; Smith and Watts, 1992; Skinner, 1993; Fan and Wong,
2002; Leuz et al., 2003; Astami and Tower, 2006; Burgstahler et al., 2006).
Since accounting choice is not necessarily opportunistic, we try to determine
which firm features and country factors may explain the accounting discretion
observed before and after IFRS. To do this we focus on the relationship
between some of the previous variables and the earnings management.
According to Watts and Zimmerman (1990), size is a proxy variable for
political attention, considering that large firms are more likely than small firms
to use accounting choices that reduce reported earnings. Scott (1991) and Rutledge (1995) study the adoption of Statement of Financial Accounting Standard 87
(SFAS 87) Employers Accounting for Pensions and SFAS 52 Foreign
Currency Translation, respectively. They find that size, among other factors, is
a determinant factor in the early adoption of these standards, and this provides
evidence of earnings management. Holland (1998) shows that firm size has an
effect on earnings management with the aim of decreasing the tax burden. In particular, in the late 1970s and the start of the 1980s evidence is found of a negative
association between firm size and effective tax rates.
Duke and Hunt (1990) provide evidence that leverage is a reasonable proxy for
the tightness of debt covenant restraints: the higher the leverage, the tighter is the
covenant constraint and the greater is the probability of a covenant violation. In
such a case managers will have more incentives to manipulate the earnings to
avoid such violation. In this regard, Jelinek (2007) shows that leverage (but
not leverage increment) increases the potential for earnings management. That
is consistent with previous research Bartov (1993), DeFond and Jiambalvo
(1994), Sweeney (1994) or Beatty and Weber (2003).
Other investigations, such as Skinner and Sloan (2002), focus on growth firms.
They find that growth stocks exhibit an asymmetrically large negative price
response to negative earnings surprises. So, managers of growth firms have incentives to manage reported earnings to avoid earnings disappointments and large
downward adjustments of the firms stock prices.
In addition to company attributes, we examine two country factors, investor
protection and legal enforcement. Leuz et al. (2003) argue that strong and
well-enforced outsider rights limit insiders acquisition of private control
benefits, and consequently, mitigate insiders incentives to manage accounting
earnings because they have little to conceal from outsiders. So, earnings management is related to investor protection. Burgstahler et al. (2006) find that minorityshareholder rights is one of the market forces and other institutional variables that
166
have the potential to differentially affect the level of earnings management. They
also document that earnings management is more pronounced in countries with
weaker legal systems and enforcement. The paper of Leuz et al. (2003) also
shows a strong (negative) correlation between the aggregate earnings management measure and enforcement proxy.
In this context, to evaluate if accounting discretion is related to firm features
and country factors we formulate hypothesis 2:
Hypothesis 2: Firms features (size, growth and leverage) and country

factors (investor protection and legal enforcement) have an effect on
accounting discretion.
3.
Sample and Methodology
3.1. Sample
The sample comprises a total of 1,408 non-financial firms listed on the stock
markets in 11 EU member states representative of the Anglo-Saxon and
Continental accounting systems traditionally identified in Europe (Table 1).
These countries are Belgium, Finland, France, Germany, Greece, Italy, the Netherlands, Portugal, Spain, Sweden and the UK. The analysis covers the period
2003 2006, split into two sub-periods (2003 2004 and 2005 2006) in order
to reflect the situation before and after the application of IFRS. The sample
comprises a total of 5,632 observations. Italy is the country with the least (144
observations) and the UK with the most (1,644). However, longer time series
are necessary to estimate discretionary accruals, which we have therefore calculated for the period 1997 2002 with two exceptions, Belgium (1999 2002) and
Sweden (1998 2002), where certain years were eliminated due to lack of data.
Table 1. Sample
Country
Belgium
Finland
France
Germany
Greece
Italy
Netherlands
Portugal
Spain
Sweden
UK
Number of firms
Number of observations
46
60
225
100
205
36
90
39
77
119
411
1,408
184
240
900
400
820
144
360
156
308
476
1,644
5,632
167
We have used the AMADEUS database, retaining only firms for which data
were available with regard to the variables considered for all the years of the
study and for the prior period used to calculate changes in certain variables, as
explained below. For each variable, we eliminated outliers, which are observations falling outside the range set by the mean value plus/minus 3 times the
standard deviation.
3.2. Methodology
Estimation of discretionary accruals. Accruals are defined as the part of revenues
and expenses that do not imply collections and payments, and are indirectly calculated as the difference between profit and operating cash flows. Assuming that
the latter cannot be manipulated, accruals (TA) would provide a way to manage
earnings. However, not all accruals are equally capable of being manipulated, and
we may therefore distinguish between non-discretionary accruals (NDA), which
are more difficult for management to massage, and discretionary accruals (DA),
which are easier. Thus, TA NDA + DA.
The following expression was used to calculate total accruals (TAit):
TAit = DReceivablesit + DInventoriesit DPayablesit DEPit
(1)
where DReceivables is the change in accounts receivable, DInventories is the

change in stocks, DPayables is the change in accounts payable and DEP is the
depreciation and amortisation expense. The subscripts i and t refer to the firm
and the year, respectively. Variations are calculated with respect to the prior year.
Since the discretionary and non-discretionary components of accruals are not
directly observable, we use the model employed in Larcker and Richardson
(2004):
TAit
1
(DSALESit DRECit )
PPEit
BMit
= a1
+ a2
+ a3
+ a4
Ait1
Ait1
Ait1
Ait1
Ait1
CFOit
+ a5
+ eit
Ait1
(2)
where TAit are the total accruals booked by firm i in period t; DSALESit is the variation in the sales of firm i in year t compared to year t 2 1; DRECit is the variation
in the accounts receivable of firm i in year t compared to year t 2 1; PPEit is the
total property, plant and equipment of firm i in year t; BMit is the book-to-market
ratio of firm i in year t; CFOit is the current operating cash flows of firm i in year t
and eit is the error term for firm i in period t. Ait21 represents the total assets of
firm i in period t 1.
This model starts from the modified version of the Jones (1991) model proposed by Dechow et al. (1995) and attempts to improve it including BM and
168
CFO.2 These variables are included because it is likely that incentives to manage
earnings vary in response to growth opportunities (BM is included as a proxy for
expected growth in the firms operations) and current operating performance
(measured by CFO).
Equation (2) was estimated for the period 1997 2002, assuming that nondiscretionary accruals (NDA) are a function of the year-on-year change in
sales, property, plant and equipment, book-to-market ratio and current operating
cash flows. It was estimated for each of the countries included in the study applying the panel data methodology, which allows the use of both cross-sectional
observation and time series.3
Here Ait21 is used as a deflator to avoid problems of heteroscedasticity. We
also used the procedure proposed by White (1980) to obtain consistent estimates
in the presence of heteroscedasticity.
Having estimated the parameters of equation (2) for 1997 2002, we applied
the values obtained to predict discretionary accruals for the period 2003 2006,
the years comprising the study period. The prediction error is interpreted as the
discretionary part of accruals, defined as
DAit
TAit
=
Ait1 Ait1

1
(DSALESit DRECit )
PPEit
BMit
CFOit
a1
+ a2
+ a3
+ a4
+ a5
Ait1
Ait1
Ait1
Ait1
Ait1
(3)
where DAit are discretionary accruals for firm i in period t, and a1, a2, a3, a4 and
a5 are the estimated values of ai .
After obtaining the discretionary accruals for each year, we may now test
whether any differences exist in the use of discretionary accruals by European
firms before and after the adoption of IFRS. This was done for each firm by calculating the mean value of discretionary accruals in absolute terms for the periods
prior to the application of IFRS (2003 2004) and for the subsequent periods
(2005 2006).
Then, we calculated the variation in absolute terms for firms in each country
and looked for any significant differences in the variation found nationally. To
this end, we applied the Kruskal Wallis non-parametric test after verifying
that the variable does not follow a normal distribution.
As well as identifying any differences that may exist between countries, we
also sought to establish the impact of IFRS in each one, that is, to learn
whether discretionary accruals in the period prior to the application of international standards are significantly different in statistical terms from discretionary accruals subsequent to implementation. The Wilcoxon non-parametric signed
rank test was applied to this purpose, after it had been established that the variable
does not follow a normal distribution.
169
The ranks obtained from the Wilcoxon test were used as the basis to establish
not only whether any significant changes occurred in discretionary accruals but
also whether these had increased or decreased. These ranks are assigned to differences between each pair of related variables, which in the present case consist of
discretionary accruals after the adoption of IFRS less discretionary accruals prior
to adoption. The test indicates the number of positively ranked cases, which is to
say those where discretionary accruals increased after the application of IFRS,
and of negatively ranked cases (i.e. those where accruals had decreased).
We also calculated the mean rise in discretionary accruals in positively ranked
firms (i.e. those displaying an increase) and the mean fall in negatively ranked
firms (i.e. those displaying a decrease).4
Estimation of current and long-term discretionary accruals. It was decided to
analyse current and long-term accruals separately because it is likely that earnings management does not affect all such adjustments equally, as DeAngelo
et al. (1994) and Arcas and Vidal (2004) argue, among others. Furthermore,
this analysis would also reveal the accounts in which firms made the most intensive use of discretionary practices.
Since total accruals are the sum of current accruals (CA) and long-term
accruals (LTA), the calculation was carried out using expressions (4) and (5),
based on equation (1), as follows:
CAit = DReceivablesit + DInventoriesit DPayablesit
(4)
LTAit = DEPit .
(5)
Current accruals are considered a function of sales and current operating cash
flows, and long-term accruals a function of fixed assets and book-to-market ratio.
Consequently, the next step is to estimate equations (6) and (7) for the period
1997 2002.
CAit
1
(DSALESit DRECit )
CFOit
= b1
+ b2
+ b3
+ eit
Ait1
Ait1
Ait1
Ait1
(6)
LTAit
1
PPEit
BMit
= g1
+ g2
+ g3
+ eit .
Ait1
Ait1
Ait1
Ait1
(7)
Starting from this point we applied the same methodology as for total accruals.
Relationship between discretionary accruals and institutional and corporate
variables. In order to determine whether institutional and corporate characteristics have an influence on accounting discretion, and which characteristic is
more related to discretionary accruals during each regulatory period, we get an
170
estimate of equation (8) by Ordinary Least Squares for the period prior to adoption of the IFRS (2003 2004) and the period subsequent to it (2005 2006). This
equation includes several corporate variables as independent: firm size (measured
by total assets), firm growth (measured by sales variation) and leverage
(measured by the volume of liabilities). All of them are deflated by the total
assets of the previous period. As for institutional factors, two variables are considered: the degree of investor protection and legal enforcement.5
DAit
1
Ait
DSALESit
LIABit
= a1
+ a2
+ a3
+ a4
+ a5 INVPROTEC
Ait1
Ait1
Ait1
Ait1
Ait1
+ a6 LEGALENF + eit
(8)
where DAit are discretionary accruals for firm i during period t, Ait is the total
assets for firm i during period t, DSALESit is the variation in sales for firm i
during year t with respect to year t 1, LIABit is the volume of liabilities for
firm i during year t, INVPROTEC stands for the degree of investor protection,
LEGALENF is legal enforcement and eit is the error term for firm i during
period t. Ait21 is the figure of total assets for firm i during the period t 1 and
we have used it as deflator in order to avoid heteroscedasticity problems.
The expected relationship between Ait (size) and the dependent variable is
positive. The bigger firms may have more incentives to manage earnings
because these firms receive more public attention than small firms (Watts and
Zimmerman, 1990; Scott, 1991). Moreover, in big firms there is a more significant distance between management, shareholders and external users of financial
information. In the framework of the agency theory it makes for easier earnings
management. We also expect a positive coefficient for DSALESit (growth); managers of growth firms may have more incentives to manipulate since investors and
other users may have overoptimistic expectations about the growth firms, resulting in negative consequences for firms if these expectations are not met (Lakonishok et al., 1994; Skinner and Sloan, 2002). The relationship between
discretionary accruals and LIABit (leverage) is a priori positive, since, as indicated by Garca Osma et al. (2005), the possibility of being unable to uphold
certain specifications of debt contracts has been regarded in accounting literature
as one of the main incentives to manipulate (see, among others, DeFond and
Jiambalvo, 1994; Sweeny, 1994; Bikky and Picheng, 2002).
Variables INVPROTEC and LEGALENF have been taken from Leuz et al.
(2003). Investor protection (INVPROTEC) is an aggregate measure of rights of
minority shareholders. This variable assesses the guarantee that markets offer
to investors. We expect to obtain a negative relation with the dependent variable,
as the more rights for investors, the fewer the incentives for manipulation, as the
capacity to benefit from manipulation shrinks. Legal enforcement (LEGALENF)
is measured by using the mean of three legal variables used in La Porta et al.
171
(1998): legal system efficiency, use of law as a regulatory mechanism and corruption index. As Leuz et al. (2003) point out, accounting rules can both limit a managers ability to distort reported earnings and affect the properties of reported
earnings, but the extent to which accounting rules influence reported earnings
and curb earnings management depends on how well these rules are enforced.
So, we expect that discretionary accruals are negatively associated with legal
enforcement.
Alternative measure for earnings management. Throughout this study we consider the existence of discretionary accruals as an indicator for the quality of earnings, in particular, and for financial reporting in general, by evaluating its
importance both before and after adopting the IFRS.
In order to assess the consistency of measurement, we have analysed the discontinuity in zero of the return on assets (ROA) by means of histograms of frequency for that variable. The aim is to detect possible irregularities in its
distribution in the intervals annexed to the reference values which, presumably,
are adopted by managers. This method can be found in Hayn (1995) and Burgstahler and Dichev (1997) and it has also been used in other studies, including
those by Degeorge et al. (1999), Gore et al. (2002), Beaver et al. (2003) and
Gallen and Giner (2005), among others.
The reference value adopted in our case is that located in zero value for return
on assets (earnings before interests and taxes divided by total assets), since there
seem to be strong incentives for earnings management to avoid small losses and
negative returns. In the graphic analysis on frequency distribution, if any irregularity should happen, a significant break will appear between those frequencies
close to the zero value for ROA, but negative, and those frequencies close to zero
value but positive. In that case, we can infer that there have been certain practices
carried out by management in order to avoid those losses and, therefore, manipulation has taken place and the quality of information is lower.
Considering that the aim of our study is to analyse the impact of adopting IFRS
on earnings management, the graphic study will focus on assessing whether that
discontinuity observed around zero profitability is higher (lower quality) or lower
(higher quality) in the period after adoption with respect to that prior to adoption
of IFRS.
4. Results
4.1. Variation in Discretionary Accounting Practices in Europe
The results of the Kruskal Wallis test (Table 2) reveal that the variation in discretionary accruals occurring after the adoption of IFRS differs in statistically
significant terms across the European countries analysed. This is the case both
for the total discretionary accruals and for current and long-term accruals
separately.
172
Table 2. Differences in the variation of discretionary accruals among countries. Results of

the KruskalWallis test
PANEL 1: Total DA
Chisquared
35.879
PANEL 2: Current DA
45.325
PANEL 3: Long-term DA
20.003
Significant at 1%; significant at 5%; significant at 10%.
Let us now consider the results obtained from the Wilcoxon test in order to
establish the effect of IFRS on the use of discretionary accruals by firms in
each country.
4.2. IFRS Effect on Total Discretionary Accruals
The results obtained from the Wilcoxon test (Table 3, Panel 1) show that total
discretionary accruals differ in statistically significant terms before and after
the adoption of IFRS in Belgium, France, Greece and the UK. However, there
was no statistically significant difference in the cases of Finland, Germany,
Italy, the Netherlands, Portugal, Spain and Sweden.
Focusing on the countries where significant differences in discretionary
accounting were observed between the period 2003 2004 and 2005 2006, the
ranks obtained from the Wilcoxon test reveal that in the four countries the
number of firms in which discretionary accruals increased after the application
of IFRS (positive ranks) exceeds the number of firms in which they decreased
(negative ranks). Furthermore, the results presented in Table 4, Panel 1 show
that the mean increment in the total discretionary accruals made by firms
where an increase was observed was greater than the mean diminution in those
firms where discretionary accruals decreased. Consequently, we may affirm
that discretionary accounting in Belgium, France, Greece and the UK increased
significantly at the time of the regulatory change.
Let us now turn to consider those countries in which discretionary accounting
did not undergo a statistically significant change based on total discretionary
accruals (Finland, Germany, Italy, the Netherlands, Portugal, Spain and
Sweden). Here (Table 3, Panel 1 and Table 4, Panel 1) we may observe that discretionary accounting has increased in the case of Finland, Italy, Spain and
Sweden, although this increase was not significant. In the case of Germany, the
Netherlands and Portugal discretionary accruals have diminished.
4.3. IFRS Effect on Current Discretionary Accruals
The results of the Wilcoxon test (Table 3, Panel 2) reveal the existence of significant differences in current discretionary accruals only in three cases: France,
Spain and the UK. In all of them discretionary accruals have increased, since
173
Table 3. Differences between discretionary accruals before and after IFRS in each
country. Results of the Wilcoxon test
PANEL 2: Current
DAa
PANEL 1: Total
DAa
Belgium
Finland
France
Germany
Greece
Italy
Netherlands
Portugal
Spain
Sweden
UK
Positive ranks
Negative ranks
Z 21.599
Positive ranks
Negative ranks
Z 20.287
Positive ranks
Negative ranks
Z 25.155
Positive ranks
Negative ranks
Z 0.101
Positive ranks
Negative ranks
Z 22.375
Positive ranks
Negative ranks
Z 21.349
Positive ranks
Negative ranks
Z 20.139
Positive ranks
Negative ranks
Z 20.921
Positive ranks
Negative ranks
Z 20.615
Positive ranks
Negative ranks
Z 20.115
Positive ranks
Negative ranks
Z 23.540
11
6
25
23
73
22
25
39
90
74
7
6
36
36
8
13
36
27
50
49
196
135
Positive ranks
Negative ranks
Z 20.544
Positive ranks
Negative ranks
Z 21.398
Positive ranks
Negative ranks
Z 25.375
Positive ranks
Negative ranks
Z 21.665
Positive ranks
Negative ranks
Z 20.878
Positive ranks
Negative ranks
Z 20.874
Positive ranks
Negative ranks
Z 20.084
Positive ranks
Negative ranks
Z 21.498
Positive ranks
Negative ranks
Z 21.937
Positive ranks
Negative ranks
Z 20.349
Positive ranks
Negative ranks
Z 24.411
PANEL 3: Long-term
DAa
9
8
27
21
70
25
26
38
76
88
7
86
32
40
7
14
40
23
54
45
203
128
Positive ranks
Negative ranks
Z 21599
Positive ranks
Negative ranks
Z 24.052
Positive ranks
Negative ranks
Z 26.607
Positive ranks
Negative ranks
Z 24.128
Positive ranks
Negative ranks
Z 27.942
Positive ranks
Negative ranks
Z 21.393
Positive ranks
Negative ranks
Z 26.476
Positive ranks
Negative ranks
Z 22.897
Positive ranks
Negative ranks
Z 23.282
Positive ranks
Negative ranks
Z 24.754
Positive ranks
Negative ranks
Z 29.852
12
5
38
10
81
14
48
16
130
34
8
5
66
6
17
4
39
24
73
26
249
82
a
Positive ranks indicate that DA after the application of IFRS (20052006) exceed DA before IFRS
(20032004), while negative ranks indicate the opposite.
Significant at 1%; significant at 5%; significant at 10%.
the Wilcoxon test ranks show that these adjustments increased in a majority of
firms and that the mean increment is larger than the mean decrease in those
firms where discretionary accruals decreased (Table 4, Panel 2).
In Belgium, Finland, Italy and Sweden current discretionary accruals have also
increased, although the effect was not statistically significant. In contrast, in
Germany, the Netherlands and Portugal discretionary accounting practices
decreased in terms of current accruals.
174

Table 4. Mean change in discretionary accruals for positive and negative ranks
PANEL 1: Total DAa
Belgium
Finland
France
Germany
Greece
Italy
Netherlands
Portugal
Spain
Sweden
UK
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
0.068
0.027
0.027
0.026
0.081
0.036
0.052
0.061
0.076
0.046
0.129
0.024
0.042
0.044
0.034
0.039
0.053
0.039
0.056
0.051
0.054
0.046
PANEL 2: Current DAa
PANEL 3: Long-term
DAa
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
Positive ranks
Negative ranks
0.055
0.049
0.026
0.024
0.077
0.025
0.049
0.064
0.051
0.050
0.088
0.043
0.033
0.034
0.044
0.047
0.051
0.049
0.048
0.047
0.050
0.043
0.018
0.012
0.009
0.004
0.013
0.005
0.009
0.004
0.011
0.009
0.028
0.009
0.012
0.006
0.009
0.005
0.009
0.002
0.017
0.010
0.013
0.009
a
Positive ranks indicate that DA after the application of IFRS (20052006) exceed DA before IFRS
(20032004), while negative ranks indicate the opposite.
In Greece, differences observed in current discretionary accruals before and

after IFRS were not significant. In this country current discretionary accruals
decreased in a majority of firms, but the mean decrease in these firms was
lower than the mean increment found in those firms where current accruals
increase. Therefore, in general terms, we can neither confirm that current discretionary accruals increased nor that they decreased.
4.4. IFRS Effect on Long-Term Discretionary Accruals

The Wilcoxon test (Table 3, Panel 3) shows that long-term discretionary accruals
in the period prior to the application of IFRS differ significantly from long-term
accruals made in the subsequent period in all of the European countries analysed
except Italy.
The number of firms in which long-term discretionary accruals increased
exceeds the number of firms in which they decreased for all countries. Looking
at the results presented in Table 4, Panel 3, moreover, we note that the mean
increment in long-term discretionary accruals for those firms where they
175
increased is larger than the mean decrease found in those firms where long-term
accruals declined. Consequently, we may affirm that there has been a significant
increase in discretionary practice as regards long-term items since the application
of IFRS in the European Union, except in Italy, where the increase has not been
statistically significant.
In light of the above, we observe that there are two countries (France and the
UK) where total, current and long-term discretionary accruals have increased significantly after the application of IFRS.
In a second group of countries, significant differences are only found in longterm discretionary accruals, but not in current or total accruals. This group is
formed by Germany, Finland, the Netherlands, Portugal and Sweden. In all
these countries long-term discretionary accruals increased after the adoption of
IFRS.
Belgium and Greece present significant differences in total and long-term discretionary accruals. In Spain, although some relevant differences in the variation
of current and long-term discretionary accruals can be observed, total discretionary accruals has not significantly changed. We can regard Italy as an exceptional
case where discretionary accruals have not experienced any significant change,
be it current, long term or total.
4.5. Relationship between Discretionary Accruals and Institutional and

Corporate Variables
The results from the estimation of equation (8), as seen on Table 5, show that all
the explanatory variables, but the variation in sales, are significant for both before
and after the introduction of IFRS. The signs of the coefficients are as expected.
This leads us to suggest that corporate variables such as total assets and liabilities are relevant in explaining accounting discretion. Both show a positive coefficient before and after the introduction of IFRS, that is, the bigger the firm and
the higher its leverage, the bigger the discretionary accruals will be, both under
local accounting rules and under IFRS.
As for the institutional variables, the two variables under investigation (investor protection and legal enforcement) show negative coefficients before and after
the introduction of IFRS. This means, as predicted, higher protection for investors
and stronger legal enforcement acted as a brake against earnings management
before IFRS were introduced, and continue to do so now they are in force.
The fact that the significant variables are the same before and after the introduction of IFRS, and that the signs for the coefficients of those variables are
also the same for both periods shows that the use of IFRS does not have an
impact on incentives or disincentives for manipulation, backing the idea that
those variations in earnings management for both periods, as shown before,
might be due to there being more room for manipulation under international standards when compared with local standards.
176
Table 5. Results of regression (8)

DAit
1
Ait
DSALESit
LIABit
= a1
+ a2
+ a3
+ a4
+ a5 INVPROTEC + a6 LEGALENF + eit
Ait1
Ait1
Ait1
Ait1
Ait1
20032004
20052006
Constant
Ait
DSALESit
LIABit
INVPROTEC
LEGALENF
R2
20.039
20.031
0.03
0.015
0.038
0.002
0.022
0.038
20.015
20.011
20.018
20.011
0.083
0.263
DAit: discretionary accruals of company i for period t.

Ait: total assets of company i for period t.
DSALESit: change in sales of company i for period t with respect to period t 2 1.
LIABit: liabilities of company i for period t.
INVPROTEC: investor protection.
LEGALENF: legal enforcement.
Ait21: total assets of company i at the beginning of the period.
177
In addition, the results reveal that a change in the basis of accounting in itself is
not enough to reduce earnings management, but that it is necessary to act on institutional factors in order to limit those practices or discourage firms from implementing them.
4.6. Frequency Distribution of Return on Assets (ROA)

The Appendix shows the frequency distribution of ROA for the periods 2003
2004 and 2005 2006 for each country under study.
As can be seen in almost all histograms, there is a significant leap around
level 0 of ROA (profit) as shown by means of a continuous line in the graphs.
The frequencies observed are much higher in the interval immediately above
level 0 for profit with respect to the immediately previous interval, which
shows lower losses. Therefore, we observe that, under both local and international rules, managers take action in order to avoid small losses, which
might entail a negative appraisal of their management. The implementation of
IFRS has not done away with those practices.
Through the comparison of distributions for each country regarding the periods
2003 2004 and 2005 2006, we can assess the impact of the adoption of IFRS.
Depending on how big the leap about 0 ROA is, the higher the leap, the higher
the practices implemented to avoid losses.
In eight of the countries under study (Belgium, Finland, France, Germany,
Greece, Spain, Sweden and the UK), there is a higher discontinuity under
IFRS than under local standards, which entails a higher level of manipulation.
In contrast, for Italy, the Netherlands and Portugal, discontinuity is lower, that
is, the adoption of IFRS has lowered management discretionary acts.
These results are consistent with those obtained for the analysis of discretionary accruals, whereby it can be said that IFRS implementation has resulted in a
higher level of earnings management in the EU.
If the comparison of results generated when studying discretionary accruals is
made country by country, it can be observed that, except for the cases of Germany
and Italy, the conclusions drawn are the same. That is, under both methods the
adoption of IFRS has benefited or damaged the reliability, and so, the quality
of financial information in the same countries.
5. Discussion of Results
With respect to hypothesis 1, the results obtained show that discretionary accruals
have increased after the mandatory implementation of IFRS in European firms.
These results seem to confirm that principles-based accounting models leave
more scope for earnings management. Nelson (2003) points out that relatively
young standard-setting regimes, such as IFRS in the EU, appear more principles-based because they have not had as much time to accrete rules. Over
time there appears implementation guidance, interpretations and technical
178
rules, and the standards tend to become more rules-based. This would be consistent with the results obtained, especially with regards to Continental European
countries, whose accounting models have been traditionally legalistic.
Yet, it is not totally correct to think that standards with a higher component of
principles than rules must necessarily generate greater manipulation. In this
sense, Nelson (2003) analyses the problem from two viewpoints: communication (level of understanding the standards in order to facilitate a shared understanding of the meaning of financial reports) and constraint (role of standards to
constraint reporting that is biased to produce an outcome consistent with management incentives).
As for communication he says that, while it is true that general rules may be
interpreted in an inconsistent way, it is also true that those additional rules
which increase exactness may be too complex to be correctly implemented.
Regarding constraint both rules-based models and principles-based models
are information biased, since there are incentives for manipulation. In the first
case, incentive-consistent reporting choices can be justified via transaction structuring or by aggressive interpretation of the evidence that is evaluated and
compared to standards requirements. In the second case, an aggressive interpretation of standards (principles) can generate bias.
Therefore, it seems to be clear that, although each type of standard has particular characteristics, they both may be wrongly implemented in the interests of
managers.
In this context, the accounting policies adopted by the management will be
related to the corporate characteristics of the companies and country factors,
although none of them explain the increase in earnings management after the
introduction of IFRS, since the results obtained with respect hypothesis 2 are
the same before and after that.
Thus, we have detected a positive and significant relationship between two
company variables (size and leverage) and the level of discretionary accruals.
As can be logically inferred the bigger a firm, the larger the gap between management, shareholders and external users of information. Thus, within the framework
of the agency theory, more manipulation practices can be implemented by the
management, seizing the opportunity provided by the accounting standards
discretion.6 These accounting choices generate agency costs in the sense that
they are opportunistic rather than optimal (Jensen and Meckling, 1976; Fama,
1980; Fama and Jensen, 1983). Moreover, the bigger firms may have more incentives to manage earnings because they are more visible than small firms (Watts
and Zimmerman, 1990; Scott, 1991).
The results show that leverage also increases earnings management, according
to the debt equity hypothesis, which suggests a positive relation between a
firms debt equity ratio and managers choice of accounting methods that
increase income (Watts and Zimmerman, 1978, 1986). Our results are in line
with those obtained by Lilien and Pastena (1982), Bartov (1993) or Jelinek
(2007). However, Fields et al. (2001) state that the evidence on whether
179
accounting choices are motivated by debt covenant concerns is inconclusive.

Other authors have focused on samples of firms either close to violating or had
already violated covenants, avoiding the use of debt as proxy of debt covenants,
and they have obtained different results (Healy and Papelu, 1990; DeAngelo
et al., 1994; DeFond and Jiambalvo, 1994; Sweeny, 1994). According to
Beatty and Weber (2003), these studies may underestimate the effect of debt
contracting on accounting choice for cases in which companies have effectively
used accounting changes to provide slack in financial covenants, and thus never
come close to covenant violations.
With regard to the country factors, the existence of incentives to manipulate
accounting figures makes it necessary to provide the accounting standards
with appropriate enforcement mechanisms and certain institutional provisions
and characteristics, such as protection for investors. In fact, in our study it has
become evident that there is a significant and negative relationship between
legal enforcement and manipulation, as well as protection for investors. This
seems to coincide with results by Leuz et al. (2003) and Burgstahler et al.
(2006).
Although the focus of our study has been on accounting earnings management,
we must discuss, in line with Ewert and Wagenhofer (2005), real earnings management (changes in the timing or structuring of real transactions). A strong legal
system with tighter accounting standards can increase earnings quality, but the
marginal benefit of earnings management increases due to a closer association
between reported earnings and the market price reaction. It is a motivation to
increase real earnings management, which is costly and directly reduces firm
value. Accounting standards are unlikely to decrease real earnings management,
so management behaviour is key to limiting total earnings management. It may
be appropriate that accounting rules be less strict, thereby reducing the marginal
benefit gained from real earnings management which could have a direct impact
on the book value.
In short, in line with Ball et al. (2003), reporting quality ultimately is determined by underlying economic and political factors influencing managers and
auditors incentives, and not by accounting standards per se. Our study shows
that the relationship between company and country variables and earnings management is the same before and after IFRS.
In our opinion, accounting standards play a relevant role in the quality of financial information, although we should not underestimate the importance of other
factors, such us legal enforcement, investor protection or some corporate
characteristics.
It is also necessary for professionals and management teams to implement the
standards in a consistent way, giving importance to professional ethics and limiting therefore aggressiveness in financial reports. In accordance with Daske et al.
(2008), only in this way will the adoption of IFRS be beneficial for stock markets.
Therefore, it is necessary for there to be strong legal enforcement and for
companies to have incentives to be transparent.7
180
6.

Conclusions
The main aim of this study was to examine whether the adoption of IFRS in the
European Union increased or decreased earnings management by comparing discretionary accruals in the periods preceding and immediately after the regulatory
change. We have not only looked at total discretionary accruals but have broken
these down into current and long-term adjustments, comparing results both
before and after the adoption of IFRS. Another objective was to determine if
some firms features and country factors explain or not the earnings management
before and after IFRS. The study was based on a sample of non-financial firms
listed on 11 European stock markets.
The results obtained show that earnings management has intensified since the
adoption of IFRS in Europe, as discretionary accruals have increased in the
period following implementation. Long-term discretionary accruals have risen
significantly in all of the countries considered except Italy, where the increase
was not significant. This fact may be connected to the differences between
IFRS and local standards with regard to the valuation criteria of property, plant
and equipment, an item that concerns long-term discretionary accruals. Meanwhile, current and total accruals have risen significantly in three and four
countries, respectively. The decreases observed were not significant in any case.
These results suggest that IFRS have actually encouraged discretionary
accounting and opportunistic behaviour, with a consequent impact on the
quality of financial information. All this is reinforced by evidence obtained
through other alternative measurements for earnings management, such as the
existence of higher discontinuities around the zero value for ROA.
However, and despite the fact that results give evidence of an increase in earnings management after the adoption of the IFRS, those variables explaining
accounting discretion are the same before and after the change of standards.
For both periods there can be seen a significant and positive relationship
between discretionary accruals and business size (asset volume) and its leverage
(use of liabilities). In contrast, the relationship between those accruals and institutional variables is negative for both periods, which implies that the level of
investor protection and legal enforcement used in implementing the standards
have helped to keep in check those manipulative practices.
The countries where earnings management has increased the most, with a significant increase for the current, long-term and total discretionary accruals are
France and the UK, countries traditionally regarded as representative of the Continental European accounting model, in the case of France, and Anglo-Saxon
model in the case of the UK. This allows us to think that the source accounting
model is not decisive for the impact of the IFRS on earnings management.
The reasons for this increase in earnings management may be related to certain
features of IFRS, which have been discussed in the literature as possible causes of
unfavourable quality outcomes. As mentioned above, these matters include flexibility, which is often greater than in the previous national standards, the
181
subjectivity implicit in the application of certain criteria such as fair value and the
lower level of requirements related to the financial statements presentation
format. Examples of options in IFRS are the choice of capitalisation or expensing
for interest costs on assets; choice of cost or fair value measurement for classes of
property, plant and equipment or for some types of intangible assets; choice of
content of statement of changes in equity, no format requirements for balance
sheet or income statement, and so on.
Nevertheless, our study focuses on the impact of IFRS on reliability, one of the
main attributes of accounting quality. Future research could study other attributes, such as timelines, conservatism, earnings volatility, etc.
Our results should be interpreted considering some limitations. First, the analysis focuses on a transitional period involving change and adaptation to the new
standards, and firms may have made the most of this to behave opportunistically.
The study reveals the actions of firms in the face of this major regulatory change.
However, it would be necessary to conduct studies with a longer time horizon
after the application of IFRS in the EU if we are to reach any final conclusion
about earnings management under international standards by European firms.
Second, the behaviour of discretionary accruals is difficult to estimate by
simple models. Third, the variables influencing on discretionary accruals may
be outside those considered in our paper.
Our results contribute to the current debate surrounding the need for professional ethics to overcome opportunism, especially in the early years of IFRS
application, and for effective control mechanisms to ensure that financial reporting achieves the desired level of quality, which will not be attained simply by the
switch from local to international accounting standards. Until now, there is literature on the impact of IFRS on comparability or relevance of accounting figures,
but not on the quality of financial information measured from the perspective of
earnings management. In this sense, the present study contributes to literature by
also comparing a high number of countries in the EU.
Acknowledgements
We acknowledge the editor, Peter Walton, and two anonymous reviewers for
many useful comments and suggestions.
182
Appendix: Frequency Histograms of Return on Assets (ROA) (Earnings

Before Interests and Taxes/Total Assets)
Fig. A1 Continued
Fig. A1 Continued
183
184
Fig. A1 Continued
185
Fig. A1 Continued
Notes
1
The IFRS model is considered to be close to Anglo-Saxon accounting systems, which have traditionally been considered less uniform than Continental European accounting models.
However, some studies have shown that accounting practices adopted by firms are not always
more uniform in European Continental countries. For example, Feige (1997) compares the
degree of uniformity of corporate reports of British and German groups with regard to foreign
currency translation, and argues that accounting practices of British firms are more uniform
than German practices.
2
A comment on the strengths and weaknesses of the main accruals models, and specifically about
Joness model and its extension can be seen in Ye (2007).
3
This method has been used in numerous papers, including Wang (1994), Hall and Stammerjohan
(1997), Han and Wang (1998), Erickson and Wang (1999), and Arcas and Vidal (2004).
4
This was done to gain a more nuanced analysis of the Wilcoxon test ranks, since it was possible
that the result would show a larger number of positive (negative) ranks but the mean increment in
the discretionary accruals made by the positively ranked firms would at the same time be lower
(higher) than the mean decrease in the discretionary accruals made by negatively ranked firms.
186
Other institutional variables which could have been introduced for the model are real estate concentrations, importance of the stock market or accounting tradition. They were ruled out due to
their high correlation (above 70%) with the variables eventually chosen.
6
In the level of earnings management, variables related with corporate governance will have influence, as shown in the papers by Beasley (1996), Dechow et al. (1996), Klein (2002), Leuz et al.
(2003), Xie et al. (2003) and Peasnell et al. (2005).
7
Whittington (2008) points out that in as much as the enforcement of the standards may vary significantly across countries, the quality of IFRS financial reports is not comparable.
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Have IFRS Affected Earnings Management in The European Union?

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Have IFRS Affected Earnings

Susana Callao & Jos Ignacio Jarne

Department of Accounting and Finance, University of

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Have IFRS Affected Earnings

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SUSANA CALLAO and JOSE IGNACIO JARNE

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S. Callao and J. I. Jarne

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Have IFRS Affected Earnings Management in the European Union?

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S. Callao and J. I. Jarne

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Have IFRS Affected Earnings Management in the European Union?

not simply a matter of switching to IFRS. Rather, the change must be

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S. Callao and J. I. Jarne

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Have IFRS Affected Earnings Management in the European Union?

S. Callao and J. I. Jarne

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Hypothesis 2: Firms features (size, growth and leverage) and country

Sample and Methodology

Have IFRS Affected Earnings Management in the European Union?

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where DReceivables is the change in accounts receivable, DInventories is the

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S. Callao and J. I. Jarne

Have IFRS Affected Earnings Management in the European Union?

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S. Callao and J. I. Jarne

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Have IFRS Affected Earnings Management in the European Union?

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S. Callao and J. I. Jarne

Table 2. Differences in the variation of discretionary accruals among countries. Results of

Significant at 1%; significant at 5%; significant at 10%.

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Have IFRS Affected Earnings Management in the European Union?

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Significant at 1%; significant at 5%; significant at 10%.

S. Callao and J. I. Jarne

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PANEL 2: Current DAa

In Greece, differences observed in current discretionary accruals before and

4.4. IFRS Effect on Long-Term Discretionary Accruals

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Have IFRS Affected Earnings Management in the European Union?

4.5. Relationship between Discretionary Accruals and Institutional and

S. Callao and J. I. Jarne

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Table 5. Results of regression (8)

DAit: discretionary accruals of company i for period t.

Have IFRS Affected Earnings Management in the European Union?

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4.6. Frequency Distribution of Return on Assets (ROA)

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S. Callao and J. I. Jarne

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Have IFRS Affected Earnings Management in the European Union?

accounting choices are motivated by debt covenant concerns is inconclusive.